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THQ Files For Bankruptcy - Promises No Disruption

News long anticipated arrived Wednesday, with the announcement that THQ Inc and its subsidiaries have filed voluntary petitions for bankruptcy under Chapter 11 of the US Bankruptcy Court for the District of Delaware. It also announced its plans to sell the company entire.

Affiliates of Clearlake Capital Group have agreed to act as the “stalking horse” by submitting a $60m bid for the troubled game manufacture under an Asset Purchase Agreement. Other potential buyers will be able to submit bids once the court has approved.

gChairman and CEO Brian Farrell said of the announcement:

The sale and filing are necessary next steps to complete THQ’s transformation and position the company for the future, as we remain confident in our existing pipeline of games, the strength of our studios and THQ’s deep bench of talent.

Which is to say, THQ is worth more to its creditors alive.

Section 363 – didn’t they do Halo 4?

This is a standard “Section 363″ procedure – essentially allowing the assets of a stricken company to be purchased free and clear of the debts attached to them. Clearwater’s offer is an aggregate totalling $60 million, including $10 million in consideration for THQ’s existing creditors.

If the court agrees – which seems likely – there will follow an auction process, with the assets going in all probability to the highest bidder. The ultimate owner will be decided by the court, although the high bid, as long as it is in the interest of the creditors, is likely to prevail.

The expectation is that this figure will provide a guide to other possible buyers of a bottom level for acceptable bids – Clearlake will not be expecting actually to buy THQ. Given that the company’s market capitalization is currently hovering around $8.5m, this suggests that there is a sense that THQ has more value whole and functional than its current share price, which has been badly affected by its financial instability, suggests.

The devil in the details

Interestingly, THQ’s press release says that there are no plans to reduce workforce during the period covered by Chapter 11, and working schedules will be maintained – again, the subtext of this statement is that THQ has value as a going concern. The pipeline of games will also, THQ claims, be unaffected. Clearlake and Wells Fargo are providing $37.5 million of “debtor-in-possession” funding during the period before any sale, which THQ are hoping can be concluded in 30 days. Wells Fargo had already declined to exercise its right to take action after THQ could not comply with the covenants of its credit agreement earlier this year.

In practice, this petition is an argument that the best hope for its creditors is some sort of negotiated solution, with THQ whole, competent and able to create and sell video games, rather than have it reduced to a collection of expensive computer equipment and reassignable IPs.

About those games

THQ’s problem and its resolution are in many ways the same. After a disastrous experiment in hardware with the uDraw drawing tablet, THQ wrote off large amounts of unsold inventory (uDraw tablets are now available for pocket change) and lost the confidence of many investors and customers. This was not helped by middling sales and the loss of the UFC franchise to EA, itself announced during a 2012 E3 event which also saw layoffs at THQ San Diego. The underperformance of Darksiders II, which received positive critical notices but failed to meet sales targets, may also have been a significant factor.

Speaking at THQ’s Q3 earnings call, President Jason Rubin said:

Observing this and other recent industry releases, one is left with a firm understanding that in the current marketplace, only the absolute top tier of releases is making impact on the game consumer. I now have an opportunity to start impacting our next slate of products and positioning them to compete in this marketplace.

This remains its challenge. THQ has promising games upcoming – in particular Metro: Last Light and South Park: The Stick of Truth. Neither is likely to do Call of Duty numbers, but both represent opportunities for profit by a new owner. Also in the pipeline are Company of Heroes 2 and the next game in the WWE franchise, which tend to be steady earners.

Conclusion

Some see THQ’s plight as a simple case of overreach – with the uDraw, and also with a series of games of wildly varying quality based on TV and children’s entertainment licenses. THQ’s Jason Rubin declared a return to focusing on core games on his appointment as President, but some of these retained projects retain a dubious scent; a sequel (in name, at least) to the underperforming Homefront planned for 2014 may find its prospects being scrutinized by any potential buyer, although Crytek’s involvement as developers may help its chances.

Others, however, question whether THQ is ultimately well-designed for the current financial climate of games. Whereas EA and Activision have scale and reliably profitable franchises, THQ has been badly affected by its recent bad run – not least reflected in a market cap that has fallen from a high of $2 billion in 2007 to its current level. A major games company could step in at a relative bargain price, and the licenses still held by THQ make a tempting package. Alternatively, private equity could seek to work its promising portfolio for profit – but the long-term future of its studios would be open to question.

Nicholas Lovell, Founder of Gamesbrief and video game consultant, sees THQ’S fall as an inevitable consequence of the narrowing AAA market: with EA and Activision (and to a lesser extent Take-Two Interactive) having franchises guaranteed to sell, THQ simply could not compete.

[THQ] owns no ‘must-have’ IP, just some ‘nice-to-have’. If the market is coalescing around 10-20 major titles a year, does THQ have any contenders?

This is a problem – Saint’s Row is a reliable money maker for THQ, but in a year with a new Grand Theft Auto game it may find its thunder stolen. Homefront was supposed to be THQ’s Call of Duty: Modern Warfare, but did not reach those heights. Metro 2033 was a surprise hit, and its sequel a subject of high hopes. And South Park is a great license, with a fine studio attached, but is not proven in the market. Arguably, THQ had to made a play for the AAA space, and could not absorb the costs when it fell short without the scale or market power of its larger rivals.

THQ risked delisting from the NASDAQ in July, but its ticker will now almost certainly be delisted within the next nine days.

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The short answer is that Homefront wasn’t supposed to sell “surprisingly well” – it was supposed to sell _well_. Modern Warfare shooters are expensive to make. Homefront has a loyal following, and the multiplayer definitely has its defenders, but where would you put it in the Modern Shooter hierarchy?

I’d put Homefront’s performance right about where one should expect a AAA first-person-shooter to land against the C.O.D. and Battlefield franchises. A proudly earned bronze medal but that is based on my assumption that Crytek will do the right thing and confidently release Homefront 2 with much fanfare.

Well, I’d remember Medal of Honor – which is pretty much the standard for decent, sequel-justifying performance for a front-rank FPS with ambivalent critical notices. Despite a metacritic score in the 70s, and some marketing issues around the OpFor megillah, Medal of Honor sold about 5 million copies. Homefront sold 2.4 million in its first two months, and had a predicted lifetime of 3-4 million. That’s past break-even, but it isn’t a solid gold franchise if you are a buyer. If you are a publisher, that’s problematic because you are looking at far lower lifetime revenues than, say, Modern Warfare (although you can do interesting things like put the multiplayer free on gaming networks) – so you have to spend less to make the game in order both to reflect that reality and to hedge against the risk of further sales erosion.

(Sales erosion is tricky – there’s a debate over whether the absurdly high sales figures for Modern Warfare games actually damage other FPS sales, or whether many of those players are totally social, and would never buy another FPS _anyway_ – the World of Warcraft lock-in. Likewise, Saints Row 4, which is still listed as a 2013 release in the bankruptcy petition docket, is helped somewhat by (a) taking a different aesthetic tack from Grand Theft Auto, but also by GTA not being _primarily_ a multiplayer experience).

And, of course, if you are a customer there is then the problem that you are being asked to pay as much for a game which cannot, looking at the simple math, have had as much money spent on its development as a first-tier FPS. So, as a marketer and publisher you have to find an angle, whether that is variation in play style or setting, or personnel (Battlefield made much of DICE, Homefront of John Milius).

This is no reflection on Homefront as a playing experience, or on the likelihood of Homefront 2 being a good (or even a great) game. It’s simply about the estimated earning potential of the possession of the Homefront 2 license to a potential buyer. Homefront didn’t fail, exactly, the way uDraw, for example, failed – but it didn’t succeed in a way that would make it a “crown jewel”.

Here’s a link to THQ’s bankruptcy court documents if anyone is interested: http://courtreads.com/?orderby=date&postcount=20&s=%23BKR100302

Particularly interesting is Docket #2, which is a declaration signed by the company’s CEO and provides a lot more details of the company’s situation, financial and otherwise. Direct link: http://courtreads.com/docket-0002-declaration-of-brian-farrell-in-support-of-the-debtors-chapter-11-petitions-and-requests-for-first-day-relief-case-thq-inc-nasdaq-thqi/#.UNJo7G_o58F